Spouse of owner with over 1000 hrs and no compensation

[Guest AlCal]

Existing tiered allocation plan defines several classes.

QUESTION 1

Some of the classes recieved a dollar contribution to be allocated proportionally to the class members compensation(comp on comp). Other classes contribution was allocated as a flat dollar amount per class participant. I beleive this is OK, but I would like some reassurance that I am not wrong.

QUESTION 2

One of the classes has as sole participant the wife of the owner. As such she is HCE. The census shows her with over 1000 hrs and $0.0 compensation. Therefore she got no allocation and only 50% of HCE were benefiting under the plan. As such the plan passed the tests. However, it would have failed them if the wife was benefiting.

The plan sponsor claims that the TPA and accountant blessed the situation. However, it seems to me that the "trick" would not fly in an audit. Any comments?

As an alternate solution: wouldn't be better to give the wife a salary and exclude her as a class? (Yes, I know they don't like to pay FICA)

Thanks for help.

[richard]

Regarding Question 1 - In general, no problem (subject to Top Heavy, if applicable). Be careful, and don't get greedy. For example, if you have a $250 flat contribution for a young employee who earns $2,500 in a year, you've got an extremely large cross-tested benefit accrual for such a tiny contribution. It just doesn't seem right, and the IRS might fight you if, for example, the employee terminated with no or little vesting.

Regarding Question 2 - I agree with your concern. It doesn't smell right.

Now, do you mean that the plan would fail if she were benefiting at the same percentage level as her husband? Why not pay her a salary, and give her no contribution or a small contribution? (The small contribution could be the same percent as one of the other classes.)

Now, I agree the client would like to save FICA tax. Assuming the husband is above $80,400, the actual after-tax cost for FICA would be about $1,000 if her pay were $10,000. Offsetting this would be the small after-tax savings on the contribution for her. (If 3% of $10,000, the after-tax savings would be about $120, depending on their marginal tax bracket.)

Several other ideas. Caveat your correspondence to them indicating your concern about an IRA audit. They might not like it, but you've got to cover yourself -- especially if it's an area that's unclear.

Another idea is have them pay her no salary but a FICA-taxable bonus before yearend of, say, $1,000, and include her in the plan at either 0% or 3% of pay. Now, the FICA cost is only $100. Now is a salary plus bonus of $1,000 reasonable? Could the IRS argue against this? No guarantees, but perhaps this mitigates the FICA expense.

Good luck.

[rcline46]

Question 1 - I agree with Richard. I have a plan with 2 flat $ classes and an age based class (father and son). Watch top heavy and 25% rules. Will not work in 2002 - bummer!

Question 2 - There are VERY few who feel volunteer work by a spouse amounts to being an employee. It would be far better to pay her and contribute -0- to her class. In the RIS Q &A at ASPA concering a sole prop with 0 net income, the Jim and Dick show feels that person would not be in the tests at all. It hinges on how one intreprets 'or entitled to be paid' in the regulations.

[Richard Anderson]

Question 1

What does the document say? You can't allocate contributions as a flat dollar amount if the document say to allocate comp to comp. If the document indeed says that the contribution may be allocated as a flat dollar amount or comp to comp at the employer's discretion, then I think that there may be a question as to whether the contribution is definately determinable. If the document says class A contribution is allocated comp to comp, and class B is allocated as a flat dollar amount; then I think that is OK.

[Guest AlCal]

Thanks to both of you for your input. The plan would not pass the 70% test if the wife will get any allocation. However I feel too that she should get compensated end either elimunate her as a class or give $0 allocation to her class. Any comment about which way would "work" better? Again, keepeing in mind that she is the wife of the owner, and as such a HCE. Also, the plan IS top heavy.

Thanks

[Richard Anderson]

Question 2

I agree with rcline46, volunteer work probably does not make a spouse an employee. How does this plan define hours? It may refer to hours paid, our plans do. If so, the spouse probably has always had 0 hours if she was paid 0.

Also, if she is in the plan and you need to give her an allocation of less than 3% in order for the plan to pass testing, make sure that the plan allocates the top heavy contribution only to NHCs.

I would leave her in a seperate class; at some point if employee demographics change, you may be able to give her a substantial contribution. Since her being in the plan is what is allowing the plan to pass, you need as much flexibliity as possible in allocating contributions to her; leave her in a seperate class.

[Guest rewarmus]

Thanks for the information re: spouse of owner with over 1,000 hrs and no compensation. I have a similar situation where a 401(k) plan is involved. Briefly, a state court ruled the wife was considered an "employee" because of the authority she possesses (eg. hire/fire employees). My question is whether or not to include the wife (who is considered an HCE via family attribution) in the ADP/ACP tests? if so, deferring 0%? Although eligible to participate in the plan, my inclination would be to exclude her altogether since there is no compensation from which she can defer. Any thoughts?

[Guest]

I've changed my thoughts on this type of thing a couple of times. Just think if family aggregation was still in effect...no, lets not go there.

If it was profit sharing, I talked myself into the following argument:

I could have set up a class plan, and regardless of the person's comp, I could have allocated 0 to that class, and so I would include in testing.

but ADP is a different issue.(?) at last years ASPA conference someone asked about a partner who had negative earned income and the response was that it was reasonable to treat the person as ineligible for testing. of course, the Q and A at ASPA carries no real weight, but it is guidance from the IRS.

One could argue ee is at 415 limit- no comp=no contr but then do you use 0% or 25% for the adp %.

I would lean toward treating her as inelegible...if she defrred in prior years you might argue taking her avg from a prior year or so. That would seem to carry some weight..."but if she had comp she would have deferred x% as indicated in the past' with no guidance you have to do something...good luck

[AndyH]

IRS Q&A 1 from ASPA 10/2000 conference may be helpful. Question is about treatment of partners with negative earned income in a 401(k) plan subject to general testing: How to treat?

Answers: For ADP test, Not a zero. Not in test.

For 401(a)(4), same answer.

I would think this is essentially the same situation.

[David]

I have a question. If you wanted to exclude the spouse from the plan, can you exclude her by name?

[AndyH]

David, I've learned from links here that the answer is yes, but to exclude somebody on a "random" (i.e. by name) basis, you need to pass the ratio/percentage (70%) test.

I've since researched this and agree. Summarized, this type of eligibility criteria would not qualify for the average benefits test for coverage purposes under 410(B), so you need to pass the r/p coverage test. If you are talking about the spouse of the owner, then she's/he's an HCE and it's easily passed.

Hope this helps. Good question.